Price Reaction to Information with Heterogeneous Beliefs and Wealth Effects: Underreaction, Momentum, and Reversal
- (pp. 1-34)
Abstract
This paper analyzes how asset prices in a binary market react to information when traders have heterogeneous prior beliefs. We show that the competitive equilibrium price underreacts to information when there is a bound to the amount of money traders are allowed to invest. Underreaction is more pronounced when prior beliefs are more heterogeneous. Even in the absence of exogenous bounds on the amount that traders can invest, prices underreact to information provided that traders become less risk averse as their wealth increases. In a dynamic setting, underreaction results in initial momentum and then reversal in the long run. (JEL D83, D84, G11, G12, G14)Citation
Ottaviani, Marco, and Peter Norman Sørensen. 2015. "Price Reaction to Information with Heterogeneous Beliefs and Wealth Effects: Underreaction, Momentum, and Reversal." American Economic Review, 105 (1): 1-34. DOI: 10.1257/aer.20120881Additional Materials
JEL Classification
- D83 Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
- D84 Expectations; Speculations
- G11 Portfolio Choice; Investment Decisions
- G12 Asset Pricing; Trading Volume; Bond Interest Rates
- G14 Information and Market Efficiency; Event Studies; Insider Trading